How to Choose the Right Incremental Borrowing Rate (IBR)

Published: January 8, 2025 | Reading Time: 10 minutes

The incremental borrowing rate (IBR) is one of the most critical—and most challenging—judgments in IFRS 16 lease accounting. An incorrect IBR can materially misstate lease liabilities by 5-15%, affecting debt covenants, financial ratios, and investor perceptions.

This comprehensive guide provides a step-by-step methodology for determining IBR, regional guidance for Singapore, Malaysia, EU, and US entities, practical calculation examples, and common pitfalls to avoid.

What is Incremental Borrowing Rate?

IFRS 16 Definition

Incremental Borrowing Rate (IBR) is defined as:

"The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment."

When to Use IBR

Use IBR to discount lease payments when:

  • Interest rate implicit in the lease cannot be readily determined (most common situation)
  • Lessor doesn't provide the implicit rate
  • Lessee cannot calculate implicit rate (requires knowledge of lessor's initial direct costs and residual value)

Practical Reality: ~95% of lessees use IBR because implicit rates are rarely available.

Why IBR Matters

IBR significantly impacts:

  • Lease Liability: Higher rate = lower present value = lower liability
  • ROU Asset: Directly affected since initial ROU = lease liability + initial direct costs + prepayments - incentives
  • Interest Expense: Higher rate = higher interest expense over lease term
  • Depreciation: Lower with higher IBR (smaller ROU asset base)

Example Impact:

5-year lease with $100,000 annual payments:

  • At 4% IBR: Lease liability = $445,182
  • At 6% IBR: Lease liability = $421,236
  • Difference: $23,946 (5.4% variance)

For lease portfolios worth millions, even 1% IBR error can materially misstate the balance sheet.

Step-by-Step IBR Determination Methodology

Step 1: Identify the Risk-Free Rate

Start with government bond yields matching the lease term and currency:

  • Currency: Use bonds in the currency of lease payments (USD lease = US Treasury, SGD lease = Singapore Government Securities)
  • Term: Match bond maturity to lease term (5-year lease = 5-year bond)
  • Source: Bloomberg, central bank websites, financial data providers

Example Risk-Free Rates (January 2025):

  • Singapore 5-Year SGS: 3.1%
  • Malaysia 5-Year MGS: 3.7%
  • US 5-Year Treasury: 4.3%
  • Euro Area 5-Year Bund: 2.5%

Step 2: Add Entity-Specific Credit Spread

Reflect the lessee's creditworthiness through credit spread:

Method A: Recent Borrowing Rates (Preferred)

  • Review recent bank loans, bonds, or credit facilities
  • Calculate spread over risk-free rate at time of borrowing
  • Adjust for current market conditions if needed

Method B: Credit Rating Approach

  • Obtain entity credit rating (S&P, Moody's, Fitch)
  • Use market credit spreads for that rating and term

Method C: Parent Company Rate (Subsidiaries)

  • Start with parent company borrowing rate
  • Adjust for subsidiary's credit profile (better/worse than parent)
  • Consider whether parent guarantee exists

Typical Credit Spreads (5-Year Term):

  • AAA Rated: +0.5% to 0.8%
  • AA Rated: +0.8% to 1.2%
  • A Rated: +1.2% to 1.8%
  • BBB Rated: +1.8% to 2.5%
  • BB Rated: +2.5% to 4.0%
  • B Rated or lower: +4.0% to 8.0%+

Step 3: Make Lease-Specific Adjustments

Consider factors specific to the lease:

Asset Type Adjustment

  • Real Estate: Typically lower rates (tangible, marketable security)
  • Vehicles: Moderate rates (depreciating but liquid)
  • Specialized Equipment: Higher rates (limited secondary market)

Security/Collateral

  • Secured by asset: Lower rate (lender has recourse)
  • Unsecured: Higher rate (general credit exposure)

Jurisdiction Adjustment

  • Different country = different economic environment
  • Emerging markets may require country risk premium
  • Consider local lending rates if significantly different

Example Adjustments:

  • Real estate lease (low risk asset): -0.2% to -0.5%
  • Specialized manufacturing equipment: +0.3% to +0.8%
  • Emerging market jurisdiction: +0.5% to +2.0%

Step 4: Validate and Document

Final validation steps:

  • Reasonableness check: Compare to recent actual borrowing rates
  • Market comparison: Review rates used by comparable companies (from disclosures)
  • Consistency check: Ensure similar leases have similar rates
  • Document thoroughly: Record methodology, inputs, sources, and judgments

Regional IBR Guidance

Singapore (SFRS(I) 16)

Starting Point: Singapore Prime Lending Rate

  • Current Range (Jan 2025): 4.25% - 5.75%
  • Source: Major Singapore banks (DBS, OCBC, UOB)
  • Typically used as base rate for creditworthy Singapore entities

Alternative: Singapore Government Securities (SGS) + Spread

  • 3-Year SGS: ~2.9% + credit spread 1.5-2.5% = 4.4% - 5.4%
  • 5-Year SGS: ~3.1% + credit spread 1.5-2.5% = 4.6% - 5.6%
  • 10-Year SGS: ~3.3% + credit spread 1.8-3.0% = 5.1% - 6.3%

Practical Example - Singapore Office Lease:

Lease: 5-year office space in CBD, SGD payments, investment-grade entity

Calculation:

  • 5-Year SGS (risk-free): 3.1%
  • Entity credit spread (A-rated): +1.5%
  • Real estate adjustment: -0.3%
  • IBR: 4.3%

Singapore-Specific Considerations

  • MAS Monetary Policy: Track Monetary Authority of Singapore policy changes
  • SIBOR/SORA: Can reference Singapore Overnight Rate Average for floating benchmarks
  • Property Cooling Measures: May affect real estate lease financing costs

Malaysia (MFRS 16)

Starting Point: Base Lending Rate (BLR)

  • Current BLR Range (Jan 2025): 6.40% - 6.65%
  • Source: Major Malaysian banks (Maybank, CIMB, Public Bank)

Alternative: Malaysian Government Securities (MGS) + Spread

  • 3-Year MGS: ~3.5% + credit spread 1.8-2.8% = 5.3% - 6.3%
  • 5-Year MGS: ~3.7% + credit spread 2.0-3.0% = 5.7% - 6.7%
  • 10-Year MGS: ~4.0% + credit spread 2.3-3.5% = 6.3% - 7.5%

Practical Example - Malaysia Retail Space:

Lease: 5-year shopping mall unit, MYR payments, BBB-rated entity

Calculation:

  • 5-Year MGS (risk-free): 3.7%
  • Entity credit spread (BBB-rated): +2.5%
  • Real estate adjustment: -0.2%
  • IBR: 6.0%

Malaysia-Specific Considerations

  • Bank Negara Malaysia (BNM) Rates: Monitor Overnight Policy Rate (OPR) trends
  • Industry Differences: Retail, F&B, manufacturing have different risk profiles
  • SME Premiums: Smaller entities may face higher spreads (add 1-2%)

European Union

Starting Point: Euro Area Government Bonds + Spread

  • 3-Year EUR Benchmark: ~2.3% + spread 1.5-3.0% = 3.8% - 5.3%
  • 5-Year EUR Benchmark: ~2.5% + spread 1.8-3.2% = 4.3% - 5.7%
  • 10-Year EUR Benchmark: ~2.7% + spread 2.0-3.5% = 4.7% - 6.2%

Country-Specific Adjustments

  • Germany (Bunds): Lowest risk-free rate (core EU)
  • France, Netherlands: +0.2% to +0.4% vs. Bunds
  • Spain, Italy: +0.5% to +1.2% vs. Bunds (peripheral EU)
  • Eastern Europe: +1.5% to +3.0% country risk premium

United States (ASC 842, but methodology applies)

Starting Point: US Treasury + Spread

  • 3-Year Treasury: ~4.1% + spread 1.5-3.0% = 5.6% - 7.1%
  • 5-Year Treasury: ~4.3% + spread 1.8-3.2% = 6.1% - 7.5%
  • 10-Year Treasury: ~4.6% + spread 2.0-3.5% = 6.6% - 8.1%

US-Specific Considerations

  • Federal Reserve Policy: Interest rate environment significantly affects rates
  • Corporate Bond Spreads: Well-established market for credit spread benchmarks
  • ASC 842 Difference: US GAAP allows risk-free rate election for non-public entities

Common IBR Pitfalls to Avoid

Pitfall #1: One-Size-Fits-All Rate

Error: Using WACC or single rate for all leases regardless of term, currency, or asset type.

Fix: Develop rate matrix with dimensions for term, currency, jurisdiction, and asset class.

Pitfall #2: Ignoring Currency

Error: Using local currency rates for foreign currency leases.

Fix: USD lease requires USD-denominated rate, even if lessee is in Singapore. Use US Treasury + credit spread, not SGS rates.

Pitfall #3: Not Updating Rates

Error: Using 2019 transition rates for 2025 new leases.

Fix: Review rates at least annually. Update for new leases. Only keep original rate for existing leases (unless remeasurement event).

Pitfall #4: Poor Documentation

Error: No support for IBR selection; unable to explain to auditors.

Fix: Document: methodology, data sources, calculation steps, judgments made, review/approval process.

Pitfall #5: Using Implicit Rate Incorrectly

Error: Calculating implicit rate without proper inputs (guessing lessor's unguaranteed residual value).

Fix: If you don't have lessor's initial direct costs AND unguaranteed residual value, you CANNOT determine implicit rate. Use IBR instead.

Pitfall #6: Ignoring Materiality

Error: Spending excessive time determining precise IBR for immaterial leases.

Fix: Apply detailed methodology to material leases. For smaller leases, reasonable approximation acceptable (document policy).

Complete IBR Calculation Examples

Example 1: Singapore Office Lease (Simple)

Facts:

  • 5-year office lease in Singapore CBD
  • SGD 300,000 annual rent
  • Lessee: A-rated Singapore public company
  • Recent bank loan at 5.2% (5-year SGD term loan)

Calculation:

  • Recent borrowing rate: 5.2%
  • Real estate adjustment: -0.3% (secured by tangible asset)
  • IBR: 4.9%

Validation: 5-Year SGS (3.1%) + A-rated spread (1.5%) + adjustment = ~4.6% ✓ Consistent

Example 2: Malaysia Equipment Lease (Build-Up Method)

Facts:

  • 3-year manufacturing equipment lease
  • MYR 500,000 annual payments
  • Lessee: BBB-rated Malaysian private company (no recent borrowings)

Calculation (Build-Up Method):

  • Risk-free rate (3Y MGS): 3.5%
  • BBB credit spread: +2.3%
  • Equipment adjustment (specialized): +0.4%
  • SME premium (private company): +0.5%
  • IBR: 6.7%

Example 3: Cross-Border USD Lease

Facts:

  • Singapore subsidiary of US parent
  • 10-year equipment lease, USD payments
  • Parent company AA-rated, has USD bonds at 5.5% (10-year)

Calculation:

  • Parent borrowing rate (USD): 5.5%
  • Subsidiary adjustment: +0.3% (slightly weaker credit than parent, no guarantee)
  • IBR: 5.8%

Key Point: Must use USD rates because lease payments are in USD, even though lessee is in Singapore.

IBR Implementation Best Practices

Build an IBR Rate Matrix

Create a structured approach:

  • Dimensions: Currency, Term (1-3Y, 3-5Y, 5-10Y, 10Y+), Asset Class (Real Estate, Vehicles, Equipment, Other)
  • Update Frequency: Quarterly review for material changes; annual full refresh
  • Approval: CFO or technical accounting team approval required
  • Application: New leases use current quarter rates; existing leases keep original rates

Documentation Requirements

Maintain audit-ready documentation:

  • Methodology memo: Describe approach (build-up vs. recent borrowing)
  • Rate sources: Screenshot/print government bond yields, credit spreads
  • Calculations: Excel models showing all components and adjustments
  • Judgments: Explain key estimates (credit spread selection, adjustments)
  • Review evidence: Sign-off from appropriate level (CFO, Controller)

Involve the Right People

  • Treasury Team: Source of recent borrowing rates, credit rating info
  • Technical Accounting: Ensure methodology complies with IFRS 16
  • External Advisors: Consider consulting for initial setup or complex situations
  • Auditors: Early discussion on approach can prevent year-end surprises

Simplify IBR-Based Lease Calculations

Our free IFRS 16 calculator handles IBR-based discounting automatically. Input your determined IBR and lease payments—get instant, accurate lease liability and ROU asset calculations with complete amortization schedules.

Calculate with Your IBR

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